Is there a bubble in index funds?

Is there a bubble in index funds?

Is there a bubble in index funds? In the first of a two-part series, WP reveals what happened when the founder and CEO of WisdomTree Jonathan Steinberg sat down for a Q&A with the CEO of Inside ETFs Matt Hougan.

Matt Hougan: Are index flows distorting market prices?

Jonathan Steinberg: I’m asked this question a lot, and it’s asked in many different ways: is there a bubble in index funds? Is there a bubble in beta? Is there a bubble in ETFs? I’m going to answer all three.

Indexing is no longer just beta, it now incorporates things like what WisdomTree does and what we call modern alpha - what some people call rules based active. We are now going for an active like experience, so indexing has exponentially increased its opportunity. I think there will be more innovation in indexing construction.

Beta, which is shorthand for liquid, transparent, tax efficient and low fee, is a very powerful solution and most active shops - particularly those doing it in structures other than an ETF - do not add value over beta, so beta will continue to suck in a lot of assets as will indexing.

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In terms of the ETF structure, there is no question it is the future of asset management. It is the better structure and incorporates active as well as traditional passive and will continue to dominate the rest of the asset management industry. In terms of distorting the market, collectively there is much more money in other structures combined. We are just a wrapper. The market will determine where the money goes and that could create bubbles, yes.

Matt Hougan: Let me ask you more of a narrow follow up to that: is there a bubble in dividend stocks?

Jonathan Steinberg: Dividends are a very constructive way to invest. They give the added benefit of income and also give investors a metric on how to measure investments. There is a lot of competition in the space of dividends or large caps in general.

I’m not sure if there is bubble but the space has collected a lot of competition and a lot of assets and I think that will continue with tax reform. We track the dividend stream closely and I think we will see significant increases in dividends. Although, not all dividend portfolios are created equally.

In addition, in a rising interest rate environment, you have to be very careful which different strategies you are putting your money in, but I think there is a lot of opportunity there.

Matt Hougan: Is a traditional cap weighted index a good approach, specifically in today’s market?

Jonathan Steinberg: We built WisdomTree on an alternative to cap weighting, and for long-term investors we believe there is a better way to invest than cap weighting. That said, when cap weighting works best it is actually in a market like this, meaning since the election the markets have been straight up.

Cap weighting is a momentum strategy and it is very hard to beat cap weighting in the short-term in a momentum market. When it corrects it can be incredibly painful, so that’s why we created our own original fundamental dividends and earnings weighted approaches. But right now, it’s a very strong way to invest.


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